The finance classroom meets the outside world (and vice-versa). Back away slowly from the computer with your hands up and your mind open, and with luck nobody gets hurt.

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Monday, June 11, 2007

Connections, Networks, and Investment Managers' Performance

One argument for going to a top school is that you get to tap into the alumni network and make connections with classmates that will help you in future years. Here's some interesting evidence that it's true in the investment world. Cohen, Frazzini, and Malloy examined how school ties affected the investment patterns of mutual fund managers in a paper, titled "The Small World of Investing: Board Connections and Mutual Fund Returns." They examined whether mutual fund managers invested differently in a company when someone from their school sat on the board. They found that:

When the manager and the board member went to the same school, the manager took a significantly bigger stake in the company

These "connected" investments gave significantly higher returns (a portfolio of connected investments outperformed non-connected ones by over 8% per year)

The abnormal returns on connected investments were concentrated around corporate events such as earnings announcements.

It's a pretty interesting piece - it appears that they superior returns weren't merely a reflection of the managers knowing more about the ability of the board member. The most telling finding was that the returns were concentrated around specific news events. Hence, they were more likely to be driven by "inside" information.